INFLATION: WHEN WILL THE FED MAKE A PREEMPTIVE STRIKE?
Former Federal Reserve Board Chairman William McChesney Martin once said that it's the Fed's job to take away the economy's punch bowl just when the party gets going. He was referring to hiking interest rates in the face of rapid growth that might fuel inflation. Right now, economists are beginning to wonder if the Alan Greenspan Fed is about to holler "last call."
Strong growth and potential inflation are clearly on the Fed's mind. In fact, Fed Vice-Chairman David W. Mullins Jr. went so far as to say on Dec. 7 that monetary policy is at an "important crossroads," a time that comes along maybe only "once every decade." His comments made ears prick up from Washington to Wall Street. The question now is not will the Fed tighten, but when?
The economy is certainly on a roll. The latest sign comes from a key area: the labor market (page 34). November payrolls scored a solid gain, the jobless rate dropped sharply, full-time jobs replaced part-time work, and the factory workweek hit a postwar high (charts).
In October, the government's refurbished index of leading indicators rose for the third month in a row, and consumers felt frisky enough to add a huge $8.1 billion to their installment debt. The data are more evidence that fourth-quarter growth could top 4% and that the economy has momentum heading into 1994.
To be sure, even though Mullins--or anyone else--would be hard-pressed to point to signs of an imminent pickup in inflation, the Fed will want to hike rates preemptively, before price pressures become ingrained. As a result, at its upcoming meeting on Dec. 21, the Fed is very likely to make an official shift in its policy predisposition that would bias its next action toward tightening.
But is a rate hike just around the corner? Not necessarily. With so much slack in the economy, with excellent productivity growth to hold down unit labor costs, and with intense domestic and global competition to curb price hikes, it will take more than a single quarter of 4%-to-5% growth to generate a new round of inflation.
The economy's peppier tone was evident in the Fed's own roundup of regional economic activity through Nov. 29. The report gave "a more optimistic" outlook than the summer surveys, with manufacturing, housing, and consumer spending all improving. In particular, holiday shopping, the report said, "got off to a good start."
However, the Fed will want to see how growth is progressing early next year before making a move. While the economy's momentum should carry over into the new year, growth is unlikely to match the fourth quarter's pace. That's partly because contributions from consumer spending and auto production, two big pluses this quarter, will be smaller. All this suggests that any Fed tightening may not come before spring--if then.
And don't forget falling oil prices. If crude remains at current levels--around $15 per barrel for West Texas Intermediate--through 1994, oil will be some $3 per barrel cheaper than in 1993. A decline of that size could subtract up to half a percentage point from the rate of consumer price inflation. Inflation, now headed for a seven-year low in 1993, could end up even lower in 1994.
The Fed undoubtedly will be keeping a cold eye on the warmer job markets for early signs of wage pressures, but none are likely to show up anytime soon. The 0.4 percentage-point drop in the November unemployment rate, to a three-year low of 6.4%, raised some eyebrows. It was the largest monthly decline in 10 years, and it suggested a rapid tightening in the job market.
However, data for the labor force--which includes both workers and job seekers--have bounced around in recent months, actually falling in November. This suggests that the November drop in joblessness was overstated, and the December rate may tick back up.
The better tone of the labor markets is real, though. Payrolls rose by a healthy 208,000 workers last month, for a three-month gain of 552,000 and a 12-month increase of just under 2 million. November hiring was the broadest in four years, with 61% of the 356 industries surveyed adding to their payrolls.
Also, the quality of new jobs improved. The number of people working part-time because they could not find full-time jobs fell for the second month in a row, to the lowest level in more than two years. And higher-paying jobs in the goods-producing industries scored gains. Manufacturing and construction added about 30,000 jobs apiece in November, bringing the two-month increase in both sectors combined to 102,000, the strongest such showing in five years.
More hiring in manufacturing and construction seems likely. The factory workweek rose to a postwar record 41.7 hours in November, up from 41.6 hours in October. Overtime, up to 4.4 hours from 4.3, was also a record.
With the workweek so long, with orders up three months in a row, and with the ratio of inventories to sales at a record low, factories will be gearing up both output and payrolls in coming months. And the rebound in housing will keep construction payrolls expanding.
A big reason why the Fed won't have to play party pooper soon is that wage growth, while strong enough to lift consumer spending, is not fast enough to touch off inflation worries.
In November, hourly wages rose 0.2%, to $10.94, after a 0.6% gain in October. Weekly pay was up an even stronger 0.5% in November, boosted by the long workweek, especially in overtime. The gain in weekly pay, along with the strong job growth, suggests that personal income scored a healthy increase last month.
Even so, the central bank doesn't have to worry about wage-cost pressures building in the economy. That's because most of the extra pay is being covered by increased productivity. The Commerce Dept. revised third-quarter output per hour worked in the nonfarm sector to show a 4.3% annual rate of growth, the strongest in six years. As a result, unit labor costs fell at a 0.6% pace, and productivity is on track to score another impressive gain this quarter.
Fatter paychecks are fueling consumers' urge to splurge. But what's interesting about this holiday season is the buying spree in durable goods, such as furniture and appliances. That reflects the spillover effects of the recent strengthening in housing demand.
In addition, sales of domestically made vehicles have been roaring (chart). Cars and light trucks sold at an annual rate of 13.4 million at the end of November--a rate hit only one other time in the past two years. That pushed monthly purchases of vehicles to 12.7 million, the highest pace in almost three years.
In light of all of the spending on durable goods, it should not be surprising that consumers are borrowing more, because most big-ticket items are financed. Installment credit surged again in October, by $8.1 billion. That was the fourth consecutive month that consumer credit has increased by more than $5 billion (chart).
Auto financing was the driving force behind the October borrowing binge. It rose $3.9 billion--the largest monthly gain in more than five years. And revolving debt, which includes credit cards, increased $3.2 billion, on top of a $3 billion advance in September.
This increased use of credit indicates that household budgets are in better shape than they were a year or two ago. Another sign of healthier finances: The Mortgage Bankers Assn. reports that only 4.21% of mortgages were delinquent for more than 30 days in the third quarter, the lowest rate in 19 years.
To be sure, at some point in this expansion, employment and industrial operating rates will start rising fast enough to heat up price pressures. And it's likely that before that time, the Fed will move to restrain the economy from suffering an inflationary hangover. But that act of temperance still seems several months away. Until then--cheers.JAMES C. COOPER AND KATHLEEN MADIGAN